U.S. stock market on May 30, 2017: thoughts and outlook

*These are our short term thoughts on the market. We combine our medium-long term model and discretionary outlook when making investment decisions. We’re looking at how the market reacts to news, earnings, and other fundamental themes related to the key individual sectors.

Stock index & news

With Amazon hitting $1000 a share on the intraday, some investors are worried that:

Breadth is too weak.

This FAANG-led rally will come to an abrupt end unless other sectors pick up the slack.

Yes, it is true that breadth is “weak”. Yes, it is true that the big tech stocks have accounted for the majority of the S&P’s gains year-to-date.

And yes, we do believe that a small 6% correction can begin at any time now (see our reasoning), which is why we’re sitting on 100% cash.

However, this small correction will not happen because of “weak breadth”. Weak breadth is an irrelevant factor. During big rallies within bull markets, it is very normal for breadth to be “weak”. Throughout the second half of the 1990s, a few big-name tech stocks accounted for most of the S&P’s gains. Throughout the 2003-2007 bull market, a few big financial stocks accounted for most of the S&P’s gains. There is nothing bearish about “weak breadth”.

In fact, we are starting to see sector rotation. This is healthy and normal for big rallies within bull markets. Over the past 2 weeks, the consumer discretionary sector has started to rally strongly. Here’s XLY’s chart (XLY is the consumer discretionary ETF).

Stock market volatility has been very low in 2017. We’ve only had 10 days this year in which the S&P moved more than 1% (up or down). This is a medium-long term bullish factor for the market. Historically speaking, the market is strongest when it slowly but steadily grinds higher. The S&P slowly grinded higher in 1995 and 2013, which were great years for the S&P.

Despite the extremely bullish sentiment in the European/German stock markets, DAX has underperformed the S&P in the last 3 weeks. Some people think that this is a bearish sign for the global stock markets. It is an irrelevant sign. Who knows when DAX will outperform the S&P again. Focus on the U.S. stock market itself.

Bottom line

The S&P will make a 6%+ small correction soon because it’s been too long since the last small correction. The market doesn’t need any fundamental reason/news to make a small correction. It can happen purely for technical reasons (i.e. mean reversion).

Perhaps the ongoing Trump-Russia investigation will be the trigger for this small 6%+ correction.

Banks have opposing views on oil. Goldman thinks that oil prices will fall while Morgan Stanley thinks that oil will slowly rise to $60. Who knows.

Sectors

Energy

The energy sector pulled down the S&P 500 today because oil prices fell. Previously, we said that oil should fall because U.S. production is surging. Then we said that perhaps oil won’t fall (see posts here and here). In all honesty, we don’t know if oil will fall or not. We don’t trade oil and don’t have a very good understanding of the oil market.

Here’s XLE (energy sector ETF). As you can see, XLE just made a new low in its decline.

Interest rates might fall a little more, but it’s unlikely that rates will fall below 2%. Hedge funds are extremely long bonds (and bearish on rates). Over the past 2 years, they have been consistently wrong on the bond market. Here is the 10 year Treasury yield, and then XLF (finance ETF).

Information technology

Tech continues to lead this rally, which is normal. The tech sector is the “growth story” sector of this era.

Consumer discretionary

There’s a specific reason why the consumer discretionary sector is outperforming the S&P. Tech stocks account for 20% of the consumer discretionary sector and XLY.

Amazon accounts for 14%

Priceline accounts for 3.5%

Netflix accounts for 2.5%

*These numbers were updated as of March 31, 2017. Since then, these tech stocks have soared, which means that are an even bigger component of the consumer discretionary sector now.

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